Question

I need to do a presentation about the following situation:

LPD Ltd is a medium sized public company which operates within the manufacturing sector.

The assets include a large number of non-current assets such as Plant and Machinery items. The CFO currently prepares the annual financial statements using the Cost model however is considering changing to the Revaluation (fair value) method.

In order to assist with his decision, he needs to know the impact that this change will have on the financial statements and reports. The company is in it’s growth stage and wants to continue attracting new investors with its impressive financial results.

Required:

Discuss the differences between the Cost model and the Revaluation model. In particular, highlight the different impact each model will have on the financial statements. Discuss the effect on each financial statement individually; Balance sheet, Statement of Changes in Equity and Income statement. Also consider any effects on financial analysis and the cost of implementing each model. Each point of discussion needs to address the differences and whether it will encourage new investors to LPD Ltd.

Provide a recommendation in your conclusion as to which model you suggest Jasper Ltd to follow given the company’s current strategy of new investment.

Answer 1

Cost model is the initial amount ( cost) of assets recognized in the books of accounts less its accumulated depreciation.

Revaluation model is the revalued amount of the asset recognized in the books of accounts less its accumulated depreciation and impairment loss

In cost model : the fixed assets are carried at their Historical less Accumulated depreciation and Accumulated impairment losses. There is no upward adjustment to value due to changing circumstances

In revaluation model : an asset is initially recorded at cost but subsequently its carrying amount is increased to account for any appreciation in value. The difference between cost model and revaluation model :  is that revaluation model allows both downward and upward adjustment in value of an asset while cost model allows only downward adjustment due to impairment loss

Cost model
When an entity adopts the cost model, the property, plant and equipment shall be carried at its cost less subsequent accumulated depreciation and impairment losses:

Carrying amount under the cost model = cost – accumulated depreciation – accumulated impairment losses.

Revaluation model
When an entity adopts the revaluation model, the property, plant and equipment shall be carried at a revalued amount less subsequent accumulated depreciation and accumulated impairment losses:

Carrying amount under the revaluation model = revalued amount – accumulated depreciation – accumulated impairment losses

The impact of derecognition of the asset is the same under both revaluation model and cost model. Even though selection of either cost model or revaluation model changes net period income, their impact on comprehensive income is same as long as TFA asset is represented in balance sheet.

An entity can choose either the cost model or the revaluation model to account for property, plant and equipment after it has been initially recorded in the books as an asset.The cost model is simple while the revaluation model is more complicated.

It is advised to follow cost model to account PPE , which is easier than revaluation model